Vol. 77, No. 11, November
Representing Chapter 7 Bankruptcy Debtors:
Going for Broke
Bankruptcy is a unique practice area with its own language and
procedures not found elsewhere in the law. With Chapter 7 consumer
bankruptcies on the rise, more lawyers will be called on to represent
debtors in these procedures. This article assists general practitioners
in representing typical Chapter 7 consumer debtors.
by James W. McNeilly Jr.
Chapter 7 bankruptcy proceeding filings in the Western District of
Wisconsin have increased from fewer than 3,000 cases per year in 1989 to
approximately 6,500 cases per year in 2001.1
In the Eastern District, Chapter 7 filings went from 5,475 in 1989 to
11,911 in 2001.2 In 2003, nonbusiness
bankruptcy filings outnumbered business filings nationally 1,625,208 to
35,037.3 This trend suggests that more
lawyers may be asked to assist their clients in filing Chapter 7
bankruptcies. This article is directed at assisting general
practitioners in representing typical Chapter 7 consumer debtors.
Unusual or complex situations, such as a married debtor filing singly,
prebankruptcy planning, or adversary proceedings, are not covered.
Chapter 7 Basics
Chapter 7 bankruptcies, sometimes called "straight bankruptcies" or
"liquidations," are what most nonlawyers think of when they think of
bankruptcy. The purpose of a Chapter 7 is the release of personal
liability for debts, called a "discharge."
According to one theory, the word "bankruptcy" is derived from the
medieval Italian words meaning "broken bench." The merchants of the time
sold their wares in the marketplace on benches. If a merchant could not
pay his debts, creditors would seize and liquidate all of the merchant's
assets, dividing the proceeds among themselves. Then, they would break
the merchant's bench, presumably to prevent the now "bankrupt" merchant
Theoretically, a similar process occurs in a modern Chapter 7
bankruptcy. The debtor declares bankruptcy, his or her assets are seized
and liquidated, and the proceeds are divided among the creditors. Unlike
in medieval times, the debtor today receives a discharge of personal
liability on all dischargeable debts.
In actual practice, the debtor keeps all of the debtor's property in
virtually all consumer Chapter 7 bankruptcies. The debtor has the right
to protect certain assets, called "exemptions," because the property is
exempt from being liquidated to pay debts. However, the bankruptcy does
not discharge liens on the debtor's property unless certain procedures
are followed and only then in specific circumstances. The debtor may
retain assets subject to liens, provided 1) there is little or no equity
in the property that cannot be exempted and 2) the debtor pays the
secured debt. Most debtors do not own any property that is either not
subject to liens or is exempt. As a result, the only event of
consequence in most consumer Chapter 7 bankruptcies is the discharge of
debts. These cases are known as "no asset" or "no distribution" cases.
The debtor's ability to receive a discharge does not depend on whether
the case is a no distribution case or, its opposite, an "asset
Most debtors are entitled to a discharge,4 and most debts are dischargeable.5 The debts that are not dischargeable are
specified. Some debts, such as certain taxes, are simply deemed
nondischargeable. Other debts can be determined to be nondischargeable
only if a creditor prevails in objecting to the discharge of that
particular debt. The debtor can be denied a discharge of all debts under
certain circumstances.6 Objections to the
debtor's discharge or to the discharge of a particular debt must be
brought by filing an adversary proceeding. Adversary proceedings are
lawsuits brought in connection with the bankruptcy. The Bankruptcy Code
- 11 U.S.C. sections 101-1330 and the Federal Rules of Bankruptcy
Procedure, collectively, the "Code" - provides a 60-day period, which
runs from the date of the creditors' meeting, in which to file an
objection to discharge.7 Under 11 U.S.C.
section 727(d), a discharge also may be revoked under certain
circumstances (usually because the debtor committed fraud in connection
with the case or did not cooperate with the administration of the
If the case is a no asset case, and no objection to the discharge is
filed, the debtor receives the discharge and the case is closed.
A full discussion of attorney fees is beyond the scope of this
article. At a minimum, however, readers should be aware of a recent
Seventh Circuit decision, Bethea v. Robert J. Adams &
Associates,8 in which the court held
that there are only two lawful attorney fee arrangements when
representing a debtor in a Chapter 7 bankruptcy: 1) full payment before
the bankruptcy is filed; or 2) full payment for the services performed
before the filing, with a separate agreement, which must be entered into
after the filing, for services performed after the filing.
Unfortunately, there are legal, ethical, and practical problems with
both types of fee agreements, and practitioners are struggling with how
to handle attorney fees in Chapter 7 cases.
Petition, Schedules, and Statement of Financial Affairs
A Chapter 7 bankruptcy proceeding is commenced when the petition - a
formal request for relief under the Bankruptcy Code - is filed. When the
petition is filed, an order for relief is invariably issued in a
voluntary case. The debtor also must file schedules and a statement of
financial affairs (collectively referred to as "the schedules"). While
the schedules often are filed with the petition, an "emergency filing,"
consisting of the petition and minimal other documents, may be used to
commence the case and trigger the automatic stay (defined below).
An emergency filing is important when the debtor needs the automatic
stay imposed as soon as possible - for example, when the debtor's wages
are being garnished. The remaining schedules must be filed within 15
days, unless an extension is granted on motion.9 Because the debtor signs the schedules under oath,
incorrect or misleading information can result in a denial or revocation
of the debtor's discharge and criminal prosecution.10 The schedules must be filed on official
forms.11 The documents may be filed on
paper or electronically. The forms can be obtained from numerous sources
such as the Wisconsin State Law Library, on the Web, and from various
bankruptcy software providers.12
The schedules divide debts into categories: secured, unsecured
priority, and unsecured. Secured debts are obligations secured by liens
on property. Unsecured priority debts are specific classes of debts
given priority by the Bankruptcy Code. Unsecured debts are the
remainder. The debtor claims exemptions on Schedule C. In Wisconsin,
debtors have the choice of using the Wisconsin statutory exemptions,
contained primarily at Wis. Stat. sections 815.18 and 815.20, or the
federal exemptions at 11 U.S.C. section 522. The debtor must choose
between the state and federal exemptions. The trustee and creditors have
30 days from the date of the creditors' meeting or from the date of an
amended Schedule C filing, whichever is later, to object to the claimed
The statement of financial affairs is a series of questions that
assist the trustee, creditors, and the court in discovering nonexempt,
unsecured assets, preferences, and fraudulent transfers, and in
determining whether grounds exist to deny the debtor's discharge or to
bring a motion to dismiss the case based on substantial abuse.
"Substantial abuse" is defined later in this article.
The schedules (except for the statement of intentions) may be amended
at any time before the case closes.14
However, courts will sometimes not allow an amendment to be made to
Schedule C after the trustee has begun to administer an asset.
"Administer" means to liquidate the asset for the benefit of
Proper Techniques for Preparing the Schedules
It is more efficient and cost-effective for the attorney and the
client if the debtor is responsible for obtaining the information
necessary to prepare the schedules. For the same reason, many firms use
paralegals to help prepare the schedules, under attorney supervision. To
ensure that all relevant facts in all cases are captured, it is
absolutely necessary for the attorney to meet with the debtor at least
once to thoroughly review the schedules before filing.
The most common error in preparing schedules is the improper
investigation of the perfection of security interests. The ability of
the trustee to make use of the trustee's "avoiding powers" (discussed
below) often depends on whether a security interest is properly
perfected. For this reason, the local rules for both the Eastern and
Western Districts of Wisconsin require that information demonstrating
the perfection of security interests (such as mortgage recording) be
contained in the schedules or provided to the trustee. The attorney must
obtain and examine this information to verify whether the security
interests are perfected so that the debtor can be properly advised as to
the effect of the bankruptcy. For example, Wis. Stat. section
706.02(1)(f) requires a nonpurchase money mortgage secured by a
homestead to be signed by both spouses. (Nonpurchase money means that
the loan proceeds were not used to buy the property securing the loan.)
In some instances, such mortgages were not signed by both spouses. In
other cases, the notes and mortgages, while properly executed, were not
recorded. In such situations, the trustee may be able to avoid the
mortgage and, unless the debtor can exempt the resulting equity, the
property likely will be sold. Even though the debtor is entitled to the
debtor's homestead exemption, the debtor is not likely to be happy about
losing the homestead.
On filing the petition, virtually all actions (including, most
importantly, collection actions) against the debtor and the debtor's
property are enjoined by the automatic stay.15 The stay is called "automatic" because it is
effective immediately when the petition is filed without any other
action, and because it is effective even against creditors who have no
knowledge of the bankruptcy filing.
With certain extremely rare exceptions, the stay terminates under the
following circumstances. A stay that enjoins actions that do not involve
"property of the estate" (defined below) terminates when the debtor
receives a discharge, or sooner, if a creditor prevails on a motion for
relief from stay. When a stay that bars actions against the debtor's
property terminates depends on whether the case is a no asset or an
asset case. In a no asset or no distribution case, the stay terminates
when the trustee files a "no distribution report" (effectively, an
"abandonment" of the property) or when the debtor receives a discharge,
whichever is later. In asset cases the stay terminates only if 1) a
creditor brings and prevails on a motion for relief from stay and forces
the trustee to abandon the property that is the subject of the motion;
or 2) the debtor has received a discharge and the trustee abandons the
property on the trustee's own initiative. Abandonment is dealt with
later in this article.
Creditors usually do not bring relief from stay motions in Chapter 7
actions because by the time a hearing on a motion can be held, the stay
has already terminated due to receipt of the discharge or filing of the
no distribution report. Debtors' attorneys rarely need to deal with such
motions because: 1) most relief from stay motions are made by secured
creditors seeking to proceed with foreclosure or replevin actions; and
2) most Chapter 7 debtors are either current on their vehicle and home
loans and thus are not subject to such a motion or have no defense to
the motion because they are hopelessly behind in payments and have
little equity in the collateral.
In a Chapter 7 bankruptcy proceeding, virtually all of the debtor's
assets become the property of the bankruptcy estate (commonly called the
"estate") immediately when the bankruptcy is filed.16 Those assets remain in the trustee's legal
control and are subject to being sold for the benefit of creditors until
they are properly exempted17 or the trustee
abandons them. The trustee may abandon an asset either formally or by
failing to administer the asset before the case is closed.18 A trustee is appointed by the U.S. Trustee's
office (usually from the Chapter 7 panel)19
or, rarely, is elected by the creditors.20
The trustee performs an investigation, which has several purposes. The
main purpose is to determine whether there are any unsecured, nonexempt
assets or any assets recoverable pursuant to the trustee's numerous
avoiding powers, which are set forth in the Bankruptcy Code. If the
trustee recovers assets, the trustee liquidates those assets and
distributes the proceeds according to the priority scheme contained in
the Bankruptcy Code.
The most common avoiding powers are the powers to recover fraudulent
transfers and preferential payments. Fraudulent transfers are,
generally, certain types of transfers by the debtor before filing that
result in diminution of the bankruptcy estate.21 The term "fraudulent transfer" is somewhat of a
misnomer, because some types of transfers qualify as fraudulent
transfers even though there is no element of fraud. Most often,
fraudulent transfers are conveyances to insiders22 (generally, members of the debtor's family) for
less than full consideration or no consideration, made within one year
before filing the bankruptcy petition. The trustee has the power to
avoid these transfers and recover the assets for the creditors'
Preferences, which are governed by 11 U.S.C. section 547, can take
many forms, but usually are payments on unsecured debts. As noted above,
theoretically, the trustee gathers the debtor's assets, liquidates them,
and then divides the proceeds among creditors. Common sense dictates
that a debtor is insolvent before the actual filing. The creators of the
Bankruptcy Code decided it would be more fair if the Code provided a
"lookback" period during which payments on debts to some creditors could
be recovered by the trustee and distributed to all creditors. These
payments are called preferences because the creditors receiving such
payments are being "preferred" by the debtor. The lookback periods are
90 days from the date of filing for payments to creditors who are not
insiders and one year for payments to insiders.
James W. McNeilly Jr., U.W. 1981,
practices in La Crosse and focuses in the areas of real estate,
creditor-debtor, and estate planning. He has been a Chapter 7 panel
trustee in the Western District of Wisconsin since 1987 and has
administered thousands of Chapter 7 bankruptcies.
Bankruptcy Code Section 341 Meeting
The meeting of creditors is held not less than 20 and not more than
60 days after the order for relief is filed. This meeting is also called
the "Section 341 meeting," after the Bankruptcy Code section governing
the meeting. The trustee presides at this meeting. The trustee and
creditors question the debtor about the schedules and the debtor's
financial dealings. This is not a formal court proceeding and the
trustee cannot rule on objections.
Secured Consumer Debts
Many debtors have consumer debts secured by collateral, such as
vehicles, that they desire to retain. Additionally, some credit card
agreements grant security interests in goods purchased with the credit
card, such as household appliances and the like. Consumer debtors have
several options by which they may retain these assets.
Debts secured by nonpossessory, nonpurchase money liens in certain
assets may be avoided pursuant to 11 U.S.C. section 522(f)(1)(B).
Nonpossessory means the creditor does not have possession of the
Debtors also have the right, pursuant to 11 U.S.C. section 722, to
"redeem tangible personal property intended primarily for personal,
family, or household use, from a lien securing a dischargeable consumer
debt, if such property is exempted ... by paying the holder of such
lien the amount of the allowed secured claim." The allowed secured claim
is, in effect, the value of the collateral.23 For example, a debtor who owes $1,500 secured by
a purchase money lien on a computer worth $300 can pay the creditor the
$300 value in cash, keep the computer, and discharge the remaining
amount of the obligation.
If a debtor is unable to either avoid the lien or redeem the value,
the debtor may reaffirm (agree to pay the debt) within the deadlines set
forth in 11 U.S.C. section 521(2). 11 U.S.C. section 524(c) outlines the
requirements for both the terms and execution of these reaffirmation
More high-income debtors are filing Chapter 7 bankruptcies. 11 U.S.C.
section 707(b) provides in pertinent part: "After notice and a hearing,
the court ... may dismiss a case filed by an individual debtor under
[Chapter 7] whose debts are primarily consumer debts if it finds that
the granting of relief would be a substantial abuse." The potential for
substantial abuse has been found in situations in which the debtor has
the ability to pay a substantial portion of the debts, and is the reason
for bankruptcy schedules I and J, income and expenses. Attorneys must
carefully question debtors about their income and expenses, because many
debtors do not accurately complete schedules I and J. It is wise to ask
for pay stubs and checkbook ledgers to substantiate the debtor's income
Duty to Disclose
Concealing, destroying, falsifying, or failing to keep records can be
grounds to deny a debtor's discharge, as can failing to explain any loss
or deficiency of assets.24 These provisions
make it imperative for a debtor to be thorough in completing the
schedules and, most especially, the statement of financial affairs. The
statement consists of numerous questions, many of which deal with
transfers and transactions. Transactions with relatives are very closely
examined, because of the opportunity for the debtor to conceal assets by
transferring them to a relative with the understanding that the assets
will be transferred back after the filing. The debtor must fully
disclose all such transfers and transactions or face a possible
objection to the debtor's discharge. All bankruptcy practitioners must
advise: disclose, disclose, disclose.
Dealing with the Trustee
Chapter 7 trustees have broad powers. Trustees often make inquiries
of debtors to assist them in exercising those powers. The debtor has an
affirmative duty to cooperate with the trustee.25 The debtor may be denied a discharge, or have
the discharge revoked, for failing to cooperate with the trustee.26 Therefore, it is imperative for a debtor to
cooperate with the trustee.
Bankruptcy is a unique area with its own language, and with
procedures not found elsewhere in the law. When representing consumer
debtors in a Chapter 7 bankruptcy, the attorney should do the following.
With regard to schedule preparation: 1) do not rely on the debtor's
memory; 2) press the debtor for information; 3) obtain documents; 4)
perform necessary searches; and 5) because of the possible civil and
criminal penalties, advise the debtor: disclose, disclose, disclose. The
attorney also should assist the debtor in cooperating with the trustee.
Finally, because there is no substitute for experience, the attorney
should discuss any questions with experienced bankruptcy practitioners
before the case is filed.
1Bankruptcy Court for the Western
District of Wisconsin, Bankruptcy
Statistics Total Bankruptcy Filings by Year 1968-2001.
District of Wisconsin, Chapter 7 filings, 1992-2001.
3News Release, Administrative
Office of the U.S. Courts, Feb. 25, 2004.
4See 11 U.S.C. §
5See 11 U.S.C. §
611 U.S.C. § 727.
7Federal Rules of Bankruptcy
Procedure (FRBP) 4004(a).
8352 F. 3d 1125 (7th Cir. 2003),
cert. denied, 124 S. Ct. 2176 (2004).
1011 U.S.C. §§ 523,
727, 18 U.S.C. §§ 151-157.
12For example, forms for
bankruptcy schedules A-J are available at www.uscourts.gov/bkforms, www.wiw.uscourts.gov/bankruptcy,
1511 U.S.C. § 362.
1611 U.S.C. § 541.
1711 U.S.C. § 522(b).
1811 U.S.C. § 554.
19The U.S. Trustee's office, a
component of the U.S. Department of Justice, is responsible for
overseeing the administration of bankruptcy cases and private
2011 U.S.C. § 702. (As an
aside, in the thousands of cases in which the author has been involved,
he has never seen an election of a trustee.)
2111 U.S.C. § 548.
2211 U.S.C. § 101(31).
2311 U.S.C. § 506.
2411 U.S.C. § 727(a).
2511 U.S.C. § 521(3).
2611 U.S.C. § 727(a),